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Moody's Cuts Could Hit 'Too Big to Fail' Bank Bonds

Written by: Antoine Gara08/22/13 - 4:55 PM EDT

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NEW YORK ( TheStreet) -- Moody's Investor Service on Thursday said it was reviewing whether it will continue to assume the U.S. government will bailout the nation's largest banks when setting its bond ratings.

As a result, the agency said it could cut bond ratings for four of the nation's largest banks, and is uncertain whether other firms will also face the prospect of downgrades.

The review comes nearly five years after the U.S. Treasury injected capital into Wall Street's largest banks, all of which was later repaid, with interest. The action by Moody's could lead to ratings downgrades for Goldman Sachs , JPMorgan, Morgan Stanley and Wells Fargo .

Moody's is undecided on whether its review would lead to a downgrade of bond ratings for Bank of America or Citigroup.

"Moody's Investors Service has placed the senior and subordinated debt ratings of the holding companies for the six largest US banks on review as it considers reducing its government (or systemic) support assumptions to reflect the impact of US bank resolution policies," the agency said in a bulletin on Thursday. It will also review ratings for trust banks State Street and Bank of New York Mellon .

The review follows the ratings agency's March 2013 announcement that it would reassess its assumption that bank holding companies would receive support from the U.S. government. Currently, regulators are in the process of implementing resolution plans that seek to unwind failing banks in a way that wouldn't create havoc in financial markets or force the government to put taxpayer money at risk.

This year, large banks submitted so-called 'living wills' to the Federal Reserve to address how they would sell or resolve their sprawling businesses in a time of crisis.

Fitch Ratings holds many of the largest banks in the U.S. on review for a downgrade, but has said it no longer credits banks with the assumption that they will receive government support.

The review by Moody's could lead to the downgrade of seemingly strong banks such as Wells Fargo and JPMorgan. However, the agency said that improvements in the strength of Bank of America and Citigroup -- two of the biggest recipients of crisis-time bailouts -- might not create the need for a negative ratings review.

As post-crisis regulations evolve, Moody's plans to assess the opposing forces that may have an impact on bondholders at the holding company level should a bank become financially distressed. It noted that a lower level of systemic support could result in a higher probability of default for banks, however, orderly resolutions and a required minimum level of holding company debt may well limit losses in a default.

"In the past year, we have seen progress towards establishing a framework to credibly resolve these large systemically-important banks, as called for under the Dodd-Frank Act," Robert Young, a Moody's Managing Director, said in a statement. "We have also seen greater cooperation and discussion among international banking regulators to manage the coordinated resolution of global banking groups."